Credit - The Rebel Yell

"Those who excel in virtue have the best right of all to rebel, but then they are of all men the least inclined to do so." - Aristotle 

While watching the continuation of the US political stand-off, which as we argued last week, turned out to be more of a "False Alarm" than anything else when one takes into account the rally witnessed at the end of the week in most risky assets, we thought we would play with your mind again using a dual reference in this week's chosen title.

The first reference is a music reference from our beloved musically creative 80s period, namely Billy Idol's famous 1983 hit album Rebel Yell as we believe that, when it comes to the debt ceiling and Billy Idol's lyrics from the famous song, in the end, US politicians "in the midnight hour will cry- 'more, more, more' ", when it comes to raising the debt ceiling and issuing more debt in the process.

The second reference is more historical. The rebel yell was a battle cry used by Confederate soldiers during the American Civil War. Confederate soldiers would use the yell during charges to intimidate the enemy and boost their own morale in similar fashion to today's Republicans stand-off, although the yell had many other uses....but we ramble again. 

Some pundits have recently argued that the US government shutdown was a demonstration that the United States of America had never been more divided. On that point we agree with the recent rant of our old friend and mentor Anthony Peters in his column in IFR entitled "On civil wars". This kind of comments on how the United States of America is divided today is utter nonsense:

"Sometimes I feel like screaming. This morning it was a report on the wireless which quoted a newspaper dubbing the US government shutdown as demonstration that the country has never been more divided. I challenge this piece of nonsense on two counts.

The first count is that, as a keen student of the American Civil War (1861-1865) which over four years ended the life of around one in ten of the nation’s male population and which culminated with the assassination of the President, I find it hard in any way to hold up the events of 150 years ago against the petty posturing on Capitol Hill in 2013 and to see any measurable comparisons.

The second is that it is not the nation which is divided but the politicians who eat and sleep pork barrel politics and who do not seem to give a fig for the wellbeing of any citizen who is not a member of their respective parochial electorate.

In fact, if one takes a disciplined approach to American politics, it is not a polarisation of political opinion which is prevalent but a vicious, no holds barred, cat fight for the middle ground which is the cause of much of the current problem. It brings with it one very important question and one which is taxing the minds of both John Boehner, the Republican Speaker of the House, and of the President which is whether ultimate power should be vested in the legislature or with the executive." - Anthony Peters, SwissInvest Strategist.

Therefore in this week's conversation we will discuss the "Rebel Yell" and the US version of the "Scheduled Chicken" for the US Debt Ceiling but also look more into the implications for the future "tapering" stance of the Fed under the new leadership of "Chairwoman" Janet Yellen. 

While in recent years we have been more accustomed to European politicians playing the game of "Scheduled Chicken" on so many occasions that our head hurts, it is interesting to see the contagion spreading to the US with the senseless fear of impeding default. As the wise Lucius Annaeus Seneca" once said:"Every man prefers belief to the exercise of judgment."

As put it recently by Nomura in their recent special report from the 10th of October entitled "US Debt Ceiling: Countdown to Default?", here comes the US version this time around of the aforementioned "Scheduled Chicken":

"As the US government shutdown drags into a second week, the markets are now starting to take notice of the sobering reality that this impasse will most likely go down to the wire. Complicating the situation is the near-exhaustion of the extraordinary measures being used by the Treasury to avoid crossing over the debt-ceiling limit. Given that there is over a week to go until October 17 – the critical cross-over date at which when Treasury cash-flow management becomes less predictable – key aspects of the funding markets are experiencing a more pronounced move than during the 2011 debt ceiling run-up." - source Nomura

More pronounced? At least not in the CDS space.

It was interesting this week to watch the US 1 year CDS surge to 55 bid on the 10th of October before seeing it tighten by 25 bps the next day when the 5 year CDS level was flat at 34 bps on the bid side. So much for default risk...

When it comes to politicians shenanigans, the move seen as of late on the US sovereign CDS space has indeed been much benign than two years ago as indicated by the recent Bloomberg Chart of the Day:

"Investors appear less concerned about the wrangling over the U.S. government’s budget and debt ceiling than they were two years ago, according to Barry Knapp, Barclays Plc’s chief U.S. equity strategist.

The CHART OF THE DAY tracks one indicator that Knapp used to draw his conclusion, presented in an Oct. 4 report: the cost of credit-default-swap contracts that insure against default on U.S. Treasury securities.

Last week’s closing rate of 45.5 basis points was well below a peak of 64.4 basis points in July 2011, the last time the federal debt limit was almost breached, according to data compiled by McGraw Hill Financial Inc.’s CMA unit. Every basis point is equivalent to $1,000 a year for a contract protecting $10 million of debt." - source Bloomberg.

In continuation to the US CDS signals following the "Rebel Yell", Bank of America Merrill Lynch in their note entitled "The declining duration of fiscal concerns" from the 11th of October added the following in relation to volume in the US CDS sovereign space:
"The weekly DTCC data shows a fair amount of trading supporting the widening of CDS spreads on the US sovereign we have seen recently, as 1-year spreads widened to 60bps from less than 10bps. Specifically the net position in CDS increased by about $250mm during each of the past two weeks to about $3.6bn as of last Friday. That corresponds to about a third of the typical trading volume (not changes in net notional) in the most liquid corporate names. As trading volumes most likely exceed changes in net notional, clearly US sovereign CDS contracts have been fairly liquid over the past two weeks and the widening of spreads reflects real risk taking as opposed to a lack of liquidity. Note that the net notional is still dwarfed by what we saw in 2011, while spreads are similar. 

Assuming a 90% recovery in a CDS auction on the sovereign, at 60bps buyers of protection would need to assess a default probability higher than 6% over the next year to expect a profitable trade." - source Bank of America Merrill Lynch

Arguably the "Rebel Yell" has had more terrifying effect on the 1 month TED and in the T-bill volatility space, as displayed by Nomura in their recent special note:

"Stresses have begun to show across various subsectors of the money markets. One need not look further than the extreme moves in the 1m TED spread which inverted this past week (Figure 3). The pressure sitting on the very front end of the T-bill curve remains a function of fear over owning securities that are in the “default window.” The quick spike higher in the front end after quarters of stability is also showing up in the rolling realized vol of 1m T-bills (Figure 4)." - source Nomura

Of course the consequences of the "Cantillon effects" and the surge in all risky asset prices with dwindling liquidity on banks books, have led to consequently much more risk for heightened volatility as illustrated by not only the violent surge in T-bills volatility but no doubt in the spike in 1 month bill yields as illustrated by Bank of America Merrill Lynch in their note from the 8th of October entitled "From financial to fiscal crisis":

"The more idiosyncratic concerns this time about being repaid by US Treasury was highlighted by the huge jump today in 1-month Treasury yields to 34bps, more than double yesterday’s level of 16bps as Treasury sold $30bn of new 1-month bills (Figure 4). Clearly, given the political circumstances, the likelihood of being repaid a 1-month maturity by the private sector may well exceed the likelihood of being repaid by the public sector (though both probabilities are very high). However, in the unlikely event that it really came to a public sector default we doubt the financial sector would continue to outperform – despite banks having finally recovered from the financial crisis - amid potential systemic concerns. Such concerns include liquidity and haircut requirements of Treasury collateral supporting the short term market. This perhaps explains the small spike in FRA-OIS the past two days (Figure 1)."

- source Bank of America Merrill Lynch

After all, it does seem that, courtesy of Central Banks' generosity we do live in a Bayesian world: "For subjectivists, probability corresponds to a 'personal belief'"- source Wikipedia

Like the wise Seneca, we prefer the exercise of judgment. On that sense we agree with the comments from Bank of America Merrill Lynch from their note from the 10th of October 2013 entitled "No Apocalypse Now":

"While we have recently suggested (see "Get CRASHy") that investor behavior is becoming more exuberant, right now there are two factors that we believe reduce the risk of a major market decline in coming weeks.

First, investors have already taken out substantial protection against a sharp debt-default inspired decline in equities in the form of SPX puts and VIX calls.

Second, in a classic debt default crash, the value of equities, bonds as well as the currency is simultaneously impacted. In our view a US apocalypse trade in October would require lower equities (in particular bank stocks), a lower US dollar and higher bond yields. We believe that combination would suggest investors are questioning the credit-worthiness of the US government and/or expecting inflationary consequences of QE4 (i.e. another liquidity policy response by the Fed) and a devaluation of the US dollar. Should the Fed be forced to "extend" or "magnify" liquidity and bond yields rise, in our view risk assets would likely be severly impacted.

Despite the debt ceiling situation, both inflation expectations and interest rates do not appear to be acting in an apocalyptic manner. Aside from a sharp move higher in the 1-month T-bill, fixed income markets have been very well behaved and volatility in both stocks and currencies has been low. And Washington is now piecing together a plan to extend the debt ceiling for up to 6 weeks." - source Bank of America Merrill Lynch

So if you still want to play the "Bayesian subjectivist" here comes from Bank of America Merrill Lynch note, another bout of  "Scheduled Schedule" for you to peruse:

"-As of Monday, October 7th, the Treasury had $35 billion of cash and $92 billion in debt maneuver capacity, giving the government $127 billion in cash to deal with upcoming liabilities.

-October 17th is the date specified by the US Treasury that debt capacity will run out (BofAML estimates that payment capacity will still be $70bn).

-October 31st a $6bn coupon payment is due (BofAML estimates payment capacity at that date will have fallen to $22bn).

-November 1st the payment capacity completely runs out due to large Social Security, Medicare, defense, & veterans payments of $67bn (BofAML estimates only half payments could be made).

-November 15th a further $31bn coupon payment is due and a potential default could then be announced if the debt ceiling is not raised before this date." - source Bank of America Merrill Lynch

Moving on to the subject of the potential "tapering stance" of the new "Chairwoman" Janet Yellen, back in June 2013 in our conversation "Lucas critique" we argued:
"QE tapering"soon? We do not think so. Markets participants have had much lower inflation expectations in the world, leading to a significantly growing divergence between the S&P 500 and the US 10 year breakeven, indicative of the deflationary forces at play".

The divergence between the S&P 500 and the US 10 year breakeven, graph source Bloomberg:

The correlation between the US, High Yield and equities (S&P 500) since the beginning of the year has weakened dramatically. US investment grade ETF LQD is more sensitive to interest rate risk than its High Yield ETF counterpart HYG  - source Bloomberg:

In addition to inflations expectations, shipping has always been for us, the best significant example of the reflationary attempts of our "omnipotent" central bankers. For instance, containership lines have announced 6 rate increases in 2013, but have failed to maintain the momentum because of the weak global economy and the excess capacity which has yet to be cleared in similar fashion to the housing shadow inventory plaguing US banks balance sheet, graph source Bloomberg:

"The Drewry Hong Kong-Los Angeles container rate benchmark fell 5.3% to $1,786 in the week ended Oct. 9, the lowest level since March 2012 ($1,771). This marks the 13th week in 2013 that rates are below $2,000. Rates are about 29% lower than the July 2012 high of $2,519. Even with six increases in 2013, rates are 34.1% lower yoy and down 19.3% ytd, as slack capacity continues to pressure pricing." - source Bloomberg.

Weak global economy, with weak global demand as illustrated by shipping rates as indicated by data from the World Container Index data - source Bloomberg:

"Shipping rates for 40-foot containers (FEU) fell 3.8% sequentially to $1,601 for the week ending Oct. 3, the fourth straight decline, according to World Container Index data.
Weakness continues to be driven by Asia, as rates from Shanghai to Rotterdam fell 7.3%, followed by Shanghai to Los Angeles (down 4.8%), Shanghai to Genoa (4.7% lower) and Shanghai to New York (down 3.2%) routes. Rates rose for Rotterdam to Shanghai (4.7%) and to New York (1.6%)." - source Bloomberg.

While the recent range break-out in the Baltic Dry Index is supposedly indicative of a strong economic rebound, we think the respite is temporary - graph source Bloomberg:

Some pundits as well have become more upbeat on iron-ore freight and scrapping levels as indicated in the below Chart of the Day from Bloomberg depicting fleet expansion versus ships' scrapping. We remain wary given the deflationary forces at play - graph source Bloomberg:

"The biggest rally in iron-ore freight costs since 2009 is prompting shipowners to end the industry’s biggest scrapping program in at least three decades as older vessels bring in more money.
The CHART OF THE DAY shows how rates, in blue, for Capesize ships hauling 160,000 metric tons of iron ore rose to a 34-month high of $42,211 a day on Sept. 25. Scrapping levels are in red.
Owners have paid off debt used to buy older vessels, making them cheaper to run, so they won’t opt for scrapping as long as the rally allows them to profit from the ships, according to Erik Nikolai Stavseth, an analyst at Arctic Securities ASA in Oslo. Chinese investment in rail, buildings and infrastructure will rise 20 percent this year, creating demand for another 135 million tons of steel, Shanghai-based Citic Securities Co. says. That would require 200 million tons of iron ore, used to produce the alloy, enough to fill 180 Capesizes, according to Fearnley Consultants A/S, a research company in Oslo. Capesize fleet capacity is up 75 percent since 2008, says IHS Maritime, a Coulsdon, England-based maritime researcher. “Freight rates are expected to return to profitable levels- even for older tonnage,” said Stavseth, whose recommendations on shipping company shares returned 26 percent in the past year.
“This will potentially lead to higher net fleet growth.” World trade in iron ore will grow 6 percent to 1.17 billion tons this year, with China taking two-thirds, according to Clarkson Plc, the biggest shipbroker. Earnings for Capesize carriers sailing to China from Brazil at a $40,000 daily rate assuming a voyage time of 45 days will equate to $1.8 million, spurring owners to keep trading their ships, Stavseth said." - source Bloomberg

We remain wary because we have yet to see a clear reduction in the number of ships being broken-up - graph source Bloomberg:

We remain wary because we have not seen a confirmed rebound in Chinese Iron Ore imports which are correlated to the Australian dollar - graph source Bloomberg:

As displayed in Deutsche Bank weekly Shipping note from the 7th of October 2013, Chinese Ore Inventory remains well below 2012 levels:

- source Deutsche Bank

But there are some improvements in monthly Chinese Iron Ore Imports as indicated by Deutsche Bank:

"August iron ore imports declined by 5.6% m/m, but is still up 7.2% y/y. Given recent chartering trends, we expect to see improved imports in September." - source Deutsche Bank

We have already touched on "the link between consumer spending, housing, credit growth and shipping":
"If there is a genuine recovery in housing driven by consumer confidence leading to consumer spending, one would expect a significant rebound in the Baltic Dry Index given that containerized traffic is dominated by the shipping of consumer products."

The worry for us as of late is that consumer sentiment in the US has fallen in October to a 9th month low making us questioning the strength of the rebound in shipping, as per Ben Schenkel's article from the 11th of October entitled "Consumer Sentiment in U.S. Fell in October to Nine-Month Low":
"Consumer sentiment in the U.S. fell in October to a nine-month low as the government’s partial shutdown and the debt-ceiling debate caused outlooks to sour.
The Thomson Reuters/University of Michigan preliminary consumer sentiment index of decreased to 75.2 this month from 77.5 in September. Economists in a Bloomberg survey projected a drop to 75.3, according to the median estimate.
Households are becoming pessimistic about the economy as the shutdown heads into a third week and the deadline looms for raising the debt limit and avoiding a default. Nonetheless, improved stock values and home prices have lent support to balance sheets, especially for wealthier Americans.
“Since the shutdown began, consumer sentiment has taken a hit,” Brian Jones, senior U.S. economist for Societe Generale in New York, said before the report. “The average person is sensitive to the headlines about the debt ceiling and the adverse impact of a technical default.” Projections of the 68 economists surveyed by Bloomberg ranged from 65 to 80. The index averaged 89 in the five years leading up to the economic slump that began in December 2007, and 64.2 during the 18-month recession that ensued." - source Bloomberg.

This leads us not to believe the Fed will "taper" in 2013. For 2014, we are not too sure either...That's our own "Rebel Yell".

"What is a rebel? A man who says no." - Albert Camus 

Stay tuned!

Australian Dollar, China and Iron Ore - What's behind the Aussie strength?

"It is in revolutionary periods that the culmination of previous trends and the beginning of new ones appear." - C. L. R. James, Trinidadian journalist. 

While in previous conversations we have discussed the link between China, Iron Ore and the Australian Dollar, we thought a, update was warranted given the continued strength in the Australian dollar.

Recently, China's government tightened housing market restrictions on March 1 in cities with "excessively fast" price gains.

Chinese commodities demand tends to weaken as property development slows. The Australian dollar has historically tracked the country's iron-ore exports to China - source Bloomberg:

The Australian dollar declined massively during the global financial crisis as Chinese demand fell for Australian iron ore. The currency then strengthened as exports of the commodity rebounded, coinciding with China's 4 trillion yuan ($643 billion) fiscal stimulus.


Iron ore is used to make steel, an essential material for housing development. Over the past year, as China has sought to curb housing prices, the Aussie has also tracked the relative performance of property stocks as indicated by Bloomberg.

Since June 2012, the Aussie has tended to move in tandem with the relative performance of the Chinese property sector.

Below you have the comparison between the AUD and the spread between the Shanghai Property Index and the Shanghai index - source Bloomberg:

Property stocks underperformed until March in anticipation of China's implementation of capital gains tax to cool the real estate frenzy. China's announcement of a 20 percent capital gains tax on home sales  on the 1st of March was less stringent than anticipated hence the rebound that followed. The Aussie had also fallen toward par against the U.S. dollar over the same period.

But what has been interesting has been the growing gap between the RBA's monthly commodity price index and the Australian dollar. The Australian dollar has been surprisingly resilient, as indicated by Bloomberg:

"The Reserve Bank of Australia’s decision to cut its key benchmark interest rate to a record low reflects the Australian dollar’s resilience to previous reductions and weaker commodity prices. 

The CHART OF THE DAY shows the RBA’s monthly commodity price index diverging from the local dollar by the most since the beginning of the nation’s China-fueled resource boom a decade ago. It also tracks the overnight cash-rate target that Governor Glenn Stevens and his board reduced to 2.75 percent yesterday, the lowest level since records began in June 1959. The exchange rate “has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates,” Stevens said in his 6th of May statement.

Stevens has reduced the cash rate by 2 percentage points in the past 19 months, a period when the currency has averaged more than $1.03, compared with 72 U.S. cents in the decade prior. The Aussie was at $1.0197 at 6 p.m. in Sydney yesterday. “It’s a balance between the interest rates being at record lows and the currency being high,” said Greg Gibbs, a Singapore-based senior currency strategist at Royal Bank of Scotland Group Plc. “While the currency remains unresponsive to commodity prices or interest-rate differentials, it increases the potential for rates to go lower.” Commodity prices have tumbled 21 percent from a peak in September 2011, the RBA’s gauge shows. The index “is intended to provide a timely indicator of the prices received by Australian commodity exporters,” according to the central bank’s website." - source Bloomberg

Could the reason behind the continuous resiliency in the Australian dollar due to a rebound in Iron Ore prices?

China imported 67.1 million tonnes of the steelmaking raw material in April, the third highest amount on record and up 4% from March it seems.

And, on Wednesday benchmark CFR import price of 62% iron ore fines at China's Tianjin climbed to $130.20 a tonne, up from its 2013 low of $128.10 reached last week according to Frik Els from Mining.com.

As far as inventories are concerned and as reported by Deutsche Bank in their latest Shipping Weekly from the 6th of May 2013, while inventories improved of their 1st quarter low, they remain below 2010 levels:

- source Deutsche Bank - Shipping Weekly - 6th of May 2013.

We do not think the resiliency of the Australian dollar is due to this rebound, there is, we think more to it and it has to do with two factors.

Factor 1 - Diversification of Central Banks FX Reserves:
The rebalancing of FX reserves as indicated by John Detrixhe in his Bloomberg article from the 3rd of April - Aussie to Loonie Equal Dollar in Attracting Reserves:

"For the first time, central banks are using their reserves to buy about the same amount of currencies from Canada to Australia as they are U.S. dollars in a sign that the pace of diversification is accelerating. Allocations to so-called non-reserve assets rose by $30.1 billion in the last three months of 2012, the most in a year, while those going to the dollar increased by $31.5 billion, according to International Monetary Fund data released on March 29. The $1.4 billion gap is the closest since at least 1999.

The changing makeup of reserve assets reflects the growing clout of second-tier nations as the major developed economies see a shrinking share of worldwide gross domestic product. The U.S., euro region, U.K. and Japan accounted for 52 percent of global GDP product in 2011, down from 69 percent a decade earlier, according to World Bank data. “The new money really got applied to the alternatives, Aussie and Canada, and it’s an ongoing trend,” Greg Anderson, the North America head of Group of 10 currency strategy at New York-based Citigroup Inc., said in a telephone interview. Those currencies have “better credit, higher yield. If you could, you’d probably put your whole portfolio there but they have a scale problem, you can’t do that,” he said.

A category the IMF calls “other currencies,” and which strategists say includes the Australian, New Zealand and Canadian dollars, soared to 6.1 percent of the $6.1 trillion in allocated global reserve assets from 1.8 percent at the end of 2007. The IMF calculates the share based on central-bank data. China, the world’s biggest reserve holder, doesn’t participate.

At the same time, the dollar percentage has shrunk to 61.9 percent from 64.1 percent, and the euro’s share has dwindled to 23.9 percent from 26.3 percent. The IMF said in November that it’s considering classifying the Australia and Canadian dollars as reserve currencies." - source Bloomberg

Factor 2 - Yuan-Aussie Trades:

As indicated in Jason Scott's Bloomberg article from the 11th of April, the Australian dollar cross-currency trading has been given a very big boost by the direct trading between the yuan and the Aussie which reached A$250 million on its first day   - Yuan-Aussie Trades Were A$250 Million on First Day:

"The People’s Bank of China approved Australia & New Zealand Banking Group Ltd. and Westpac Banking Corp. as market makers for the direct trading of the currencies that began yesterday, Gillard said at a press conference in Shanghai on April 8. Asia’s largest economy took about a third of Australia’s exports in February and is its major customer for iron ore and coal. The yuan gained 0.2 percent to 6.5167 per Australian dollar as of 2:32 p.m. in Beijing, according to data compiled by Bloomberg. The Australian dollar follows the greenback and the yen in being able to be directly traded with the yuan. Before the bilateral deal, cross-currency trading between the Aussie and the yuan was about A$20 million a day, according to data compiled by market participants, who asked not to be named." - source Bloomberg.

As far as the Yuan is concerned, you should watch what happens with the Yuan's trading range in the coming months because of the competitive devaluation taking place in Japan  - source Bloomberg:

"China won’t widen the yuan’s trading range for at least four months, as foreign inflows have pushed the currency near the upper end of the 1 percent daily limit, according to Australia & New Zealand Banking Group Ltd. “It would require an easing of capital inflows, or for the market to re-assess People’s Bank of China’s currency management” before the band is altered again, said Khoon Goh, a senior strategist at ANZ in Singapore. The central bank expanded the range from 0.5 percent in April 2012 after a stretch of at least 15 months during which the yuan hovered near the midpoint or tended to weaken. A change now would be an “effective revaluation” as other nations devalue their currencies, he said.
The CHART OF THE DAY shows the onshore yuan gained 3.4 percent against the dollar in the past nine months and has closed stronger than the reference rate since September. The lower panel shows the currency stayed near the maximum 1 percent above the fixing for the last seven months.
Speculation for a change was heightened on April 18 when PBOC Deputy Governor Yi Gang said the band would be widened “in the near future.” Based on the previous adjustment, the central bank probably won’t move “until the yuan is trading closer to the midpoint,” ANZ’s Goh said.
Yuan positions at Chinese financial institutions stemming from foreign-exchange transactions, a gauge of cross-border flows, rose by 1.22 trillion yuan ($197 billion) in the first three months of 2013, more than four times as much as in the same period last year. The inflows helped push the yuan to a 19- year high of 6.1723 per dollar on April 17." - source Bloomberg.

On Thursday the Yuan hit a record high of 6.1336 per dollar in morning Asian trade after the People's Bank of China (PBOC) fixed the yuan mid-point at the highest level since the 2005 revaluation.

What will be interesting to watch in relation to China and as reported by EJ Insight on the 8th of May is as follows:

"New forex position limits could tighten cash flow Starting June 10, banks in China are required to comply with new foreign exchange position limits. The State Administration of Foreign Exchange, the nation’s currency regulator, has linked the position limits to the banks’ foreign currency loan-deposit ratios.

Market analysts estimate the lenders need to buy as much as US$320 billion worth of US dollar to meet the new ratio. This could lead to tighter cash flow in the financial system and higher money rates for a short period. As a result, the central bank may keep a net cash injection via its open market operations.

On the other hand, the new measure, which is aimed at containing the influx of speculative capital, is timely and important at a time when other major economies are exercising monetary easing.

After Australia cut interest rates on Tuesday, South Korea’s central bank is likely to announce a long awaited cut today. According to official data, yuan positions at Chinese financial institutions from foreign exchange transactions rose by 1.22 trillion yuan (US$197 billion) in the first quarter."

And Korea did cut its interest rates by 25 bps. The race to the bottom is on and currency wars are indeed interesting to follow.


"The thing is to be able to outlast the trends." - Paul Anka, Canadian musician.

Stay tuned!

Australia and the Iron Ore conundrum

"The most fatal illusion is the narrow point of view. Since life is growth and motion, a fixed point of view kills anybody who has one."
Brooks Atkinson

Following up on our recent Shipping conversations ("Shipping is a leading credit indicator - A follow up"; "Shipping is a leading deflationary indicator"), we thought we would venture towards "Down Under", namely Australia given the recent weakness of Chinese Iron-Ore Inventory which have been declining for four weeks and are now below 2011 highs represent a serious conundrum for Australia's economic growth in general and AUD-USD in particular.

Source Deutsche Bank Shipping Weekly - 21st of May 2012

In fact since the beginning of the year both the Brazilian Real as well as the Australian Dollar have experienced a significant weakness versus the US Dollar - source Bloomberg.

While both commodities depending currencies had moved in synch versus the US dollar, the correlation between both broke last year leading to significant divergence between both currencies.

In a recent note entitled "Iron Ore Summer Slowdown" published by Deutsche Bank, their analysts indicated the following:

"Iron ore exports from Brazil have disappointed. Export levels have been poor due to various factors including adverse weather and infrastructure challenges. We expect that export levels are likely to exceed 25mt/month over the next couple of quarters. This normalisation of Brazilian exports could put additional pressure on the market as well.

Certainly we would expect that both Brazilian and Australian producers will be sensitive to the demand requirements of their customers, Europe and China principally, who we expect will be under considerable pressure over the summer slowdown period. On this basis one would expect that exports may drift lower in response to this. Nevertheless we believe that the ability of the key suppliers to ship tonnage to market will improve over this time-frame."

As Dylan Grice put it in his note "Australians be worried: someone is calling your country a miracle!" from the 25th of April:

"Australia's two biggest commodity exports are iron ore and coal. According to the RBA Australia has increased its iron ore capacity by 150Mtpa in the last five years, from 300Mtpa to 450Mpta. Planned capacity increases over the next five years amount to a further 200Mtpa (see chart below). Nearly all of it will go to China to feed the burgeoning steel industry there. But how healthy is China's iron ore demand? If its steel prospects were so attractive why does Wuhan Iron and Steel for one think pigs are the future? Why has the company recently announced plans to invest nearly $5bn over the next five years in industries in which it has no expertise, such as pig, fish and organic vegetable farming? Probably because steelmakers are now loss making and there is excess capacity. And if they have no confidence in the Chinese steel industry, why should Australia?"

In fact Deutsche Bank analysts in their note "Iron Ore Summer Slowdown" remain cautious near term:

"DB steel analysts in China are cautious near-term. After average daily production volumes reached 2.03mt/day in April, utilisation rates are now starting to moderate as end-use demand fails to materialise. In fact we understand that fabricators have high levels of finished inventories. Furthermore, steel inventories while falling are being drawn down at a slower rate than is usual for this time of year."

China growth cooling and implications for Iron Ore:

"Our China steel team expects that Chinese steel production growth will average nearly 4% YoY in 2012(reaching 710mt), as compared to 7.3% growth last year. Utilisation rates are forecast to fall to 86% in 2012.

However we anticipate that these figures may be downgraded if in fact a Chinese economic recovery is delayed or if GDP growth is lower than anticipated. We have concerns about the weakness of the three major fixed asset investment (FAI) pillars (infrastructure, real estate and manufacturing). As our team has indicated previously, excessive manufacturing growth in 2011(which was the highest since 2006) is worrying as it potentially sets the stage for a capex down-cycle for the sector in 2012. Of note, the aggregate capex for Chinese companies under DB analyst coverage is projected to decline in 2012." - source Deutsche Bank.

As indicated by Reuters on the 24th of May:

"Spot iron ore prices have fallen to a 6-1/2 month low below $130 a tonne this week, as steel mills in top consumer China deferred shipments and curbed fresh buying after domestic steel prices hovered near their cheapest in half a year.

Plummeting steel prices, which have shed 6 percent in May, coupled with doubts about domestic demand, are keeping China's army of steelmakers on edge, making them reluctant to commit to new orders.

With growing uncertainty over whether iron ore prices will continue to drop, Chinese steel mills have been picking up material they do need from ore piled at ports rather than making forward bookings with miners, which can take at least 20 days to arrive from Australia."

From the same article:
"If prices were to hit $120 a tonne, it could lead to the closure of some high-cost Chinese miners."

Source Deutsche Bank - "Iron Ore Summer Slowdown" - 17th of May 2012

It's still a game of survival of the fittest in this deflationary environment...

And as Dylan Grice put it in his note focusing on Australia:

"If Chinese resource demand holds up everything will probably be fine. But if it doesn't, well, everything won't be. In fact, there might be trouble anyway. The improvement in Australia's terms of trade (the ratio of its export prices to its import prices) has been spectacular thanks to the bull run in commodities. It should be running large current account surpluses, like Norway. But it isn't. It's running a deficit of 3%. So the AUD is overvalued and vulnerable."

Hence our negative view on Australian Dollar.

"All truth, in the long run, is only common sense clarified."
Thomas Huxley

Stay tuned!

Markets update - Debit Trading - the EM contagion.

"If you don't have a functioning financial system the world economy won't be revived. All the major economies have their responsibility to assist at a pace which is required to clean up the balance sheet of the banking system and to ensure that credit flows are resumed."
Manmohan Singh

Contagion we have in Emerging markets:


Source CMA:

The trend is Ukraine:


No more Viagra ((Pfizer (PFE) long-term rating cut to A+ from AA- by Fitch; Outlook Stable) for China, as one stimulus after another is getting pulled out – this time around, it is not like Haier Electronic Group as we discussed previously with subsidies for home appliances. Instead, loan approvals are getting withdrawn:
China’s Squeeze on Property Market Nearing ‘Tipping Point’ - Bloomberg - 23rd of September:
"The squeeze on China’s property market may be reaching a “tipping point” that drives growth lower just when exports are under threat from a global slowdown and investor confidence is plunging, said Zhang Zhiwei, Hong Kong-based chief China economist at Nomura Holdings Inc.
Land transactions in 133 cities tracked by Soufun Holdings Ltd., the country’s biggest real-estate website, fell 14 percent by area in August from a month earlier. Prices of new homes declined in 16 of 70 cities last month compared with July, according to government data."

Pop goes the real estate bubble in China, from the same article:
"Property construction is a mainstay of investment that last year drove more than a half of economic growth while land sales contributed 40 percent of revenues earned by local authorities that have amassed 10.7 trillion yuan ($1.67 trillion) of debt.
A funding squeeze on developers risks a “domino effect” as companies needing cash cut prices, forcing others to follow, Credit Suisse Group AG said yesterday.
“We’re reaching a tipping point where land sales are dropping much faster than before, developers are losing more access to bank financing, and housing prices are showing weakness,” Nomura’s Zhang said in an interview in Beijing yesterday."

And Bloomberg to add:
"The price of land in Beijing slumped 76 percent in August from a month earlier, while in Guangzhou it plummeted 53 percent, according to Soufun. Land auction failures surged 242 percent in the first seven months of this year because of government curbs on the property market, the Beijing Times reported Aug. 3."

A Chinese Subprime crisis in the making?
"Some developers have turned to trust firms for financing, usually in the form of loans that are repackaged into investment products and sold to retail investors. The debt is typically funded by banks or investors themselves, according to Samsung Securities Asia Ltd."

Worst Asia Currency Drop Since ’97 Spoils Debt - Source Bloomberg:

So, no safe haven anymore even in Asia, its redemption/liquidation time for some global macro players.
Source Bloomberg - Kyoungwha Kim and Jiyeun Lee - 23rd of September:
"The Bloomberg-JPMorgan Asian Dollar Index slumped 4.3 percent this month, heading for its biggest loss since December, 1997, led by a 9.6 percent decline in South Korea’s won. Korea Exchange Inc. prices show the yield on 10-year government debt soared 27 basis points, or 0.27 percentage point, to 3.82 percent, from an all-time low on Sept. 14. The yield on similar Indonesian debt jumped 68 basis points this month to 7.47 percent, after touching a record low on Sept. 9."

And EM for Global Macro players is a crowded trade according to Bank of America Merrill Lynch research, hence the liquidation we started to see and mentioned in the post "Markets update - Credit - Anterograde and Retrograde amnesia":

Emerging Markets, which until recently had been preserved from the onslaught, have been affected as well by the revised growth picture published by the IMF, cutting its forecast to 4% from 4.3% in June 2011 - Source Bank of America Merrill Lynch Research:

So Australia and Australians banks please beware:


And given commodities based countries are in the frontline in relation to a Chinese slowdown, it is of no surprise commodities based currencies are taking a beating in the process:
AUD/USD, 2008 until the 22nd of September picture - Bloomberg:

Canadian dollar is exposed as well:

And my good credit friend to comment:
"The equity market finally realized what the credit market was” flashing” for a while… and reacted accordingly. But the race to catch back with the credit market has still a long way to go…and the path may not be a straight line. Bottom line, equities will go lower as the new “norm” of slow economy worldwide will be accepted…

Which means lower prices for commodities (goodbye Canadian dollar and Australian dollar carry trade), higher US dollar (a higher US dollar and slower growth will be the poison pill for the international US corporations)…"

No more safe havens, even in Switzerland, as the country now flirts with deflation, Japanese style:

Source Bloomberg.

Like Japan, Switzerland is suffering from currency appreciation, tipping it towards deflation in the process, with 30 year Swiss Government bonds yielding less than Japanese 30 year bonds, with a yield at around 1.30%.
The Swiss National Bank is warning that its Consumer Prices may decline 0.3% in 2012.

As a follow up on our last post where we discussed the sell-off in Emerging Markets currencies, we have now 4 countries trying to prop up their currencies, namely, Russia, India, Argentina, and now Brazil.
According to Bloomberg in relation to Brazil:
"The central bank sold 55,075 currency swap contracts in auctions, which was equivalent to selling dollars in the futures market. The last time policy makers entered the derivatives market to weaken the dollar was in June 26, 2009, according to the central bank. Yesterday’s measure marked a reversal of a 28-month-old strategy of buying dollars to weaken the currency."
Brazil Sovereign CDS climbed 23 bps on the 22nd of September to 219 bps according to CMA.

No, inflation is not the immediate threat, deflation is. US treasuries returned so far 1.7% in September, 8.9% gain year to date.

And my good credit friend added on this:
" “No more risk free assets” may result in a big re-pricing of all asset classes.

When there is too much debt in a system and when everybody is reluctant to erase the debt, the only solution is to deflate the value of the debt and the capital in order to bring them in line with the value of the assets or collateral… The trend will be “to deflate”, because we are in “deflation” … even if nobody wants to hear it."

Ratio MSCI EMERGING MARKETS/ MSCI WORLD:

"Prosperity makes friends, adversity tries them."
Publilius Syrus

Stay Tuned!